Investing on a low income.

Author: lewys

Hotel Chocolat PLC – An undervalued AIM share with room to run

Table Of Contents 1Introduction2Route to market3Economic Moat4Past Performance5Hotel Chocolat’s biggest problems6Looking to the future7Fair Value Estimate (Discounted EPS) IntroductionHotel Chocolat PLC is a prominent British chocolatier and cocoa grower that…


Hotel Chocolat PLC is a prominent British chocolatier and cocoa grower that has carved a niche with its focus on the premium chocolate market.

Combining cocoa growing and chocolate manufacturing, the company boasts a unique vertically integrated business model that sets it apart from competitors.

Hotel Chocolat currently operates almost exclusively in the UK following the recent failure of its USA and Japan ventures which management blames on the coronavirus pandemic.

Following these failures, shares have dropped to £1.40 a share at the time of writing, down over 50% in the past year.

This article will take a deep view of the company and its operations, highlighting both strengths and weaknesses, ultimately arguing that the shares are compelling at current levels based on the projected growth of UK operations alone.

Route to market

Hotel Chocolat PLC has a multi-channel approach to reach its customers, utilizing both physical stores and online platforms to maximize its market presence. See below a detailed description of Hotel Chocolat’s main routes to market.

Physical stores: Hotel Chocolat operates a network of 123 physical stores strategically located in various regions according to 2022 FY results. These stores serve as flagship locations, where customers can immerse themselves in the world of premium chocolate. The stores often incorporate cafés and the popular ‘wall of chocolate’ concept.

In-store cafés, in my opinion,offer a potential core driver of growth that deserves a bit more attention from management given the popularity of coffee chain stores in the UK.

Physical stores are Hotel Chocolat's main revenue driver, accounting for around 50% of sales.

Online presence: Hotel Chocolat has developed a robust online presence that allowed it to survive the COVID-19 pandemic. Their official website serves as an online storefront, enabling customers to browse and purchase their products from the comfort of their homes. Online sales currently account for around 35% of total revenue having dipped from pandemic-level highs.

Subscription-based model: Hotel Chocolat have also implemented a subscription-based model known as the "Tasting Club." Customers can join this club and receive a curated selection of chocolates on a regular basis, such as monthly or quarterly. This model not only generates recurring revenue but also fosters customer loyalty and engagement. These sales are reported under the 'digital' umbrella, contributing to online sales.

Wholesale and partnerships: In addition to direct-to-consumer sales, Hotel Chocolat has established wholesale relationships with selected retailers, such as John Lewis, allowing their products to reach a wider audience. They also collaborate with various partners to create co-branded or limited-edition products, expanding their market reach and appealing to different customer segments. Currently, Partners & B2B sales account for around 12% of total revenue.

The remaining 3% of revenue not noted above came from international sales in 2022 however, my analysis has assumed no international revenue moving forward despite management's current licencing approach to try once again to crack overseas markets.

Economic Moat

Readers will be aware that I usually only invest in companies with economic moats so will be surprised to learn that I do not consider Hotel Chocolat to have an economic moat.

An economic moat is like a protective barrier around a company's profits. It's a special advantage that makes it difficult for competitors to steal customers or take away market share. Imagine a castle with a deep, wide moat around it.

The moat represents things like brand loyalty, patents, unique technology, or a strong customer base. These advantages keep the company safe and give it a lasting competitive edge. Without a moat, a company is more vulnerable to competition and may struggle to maintain its profits over time. For this reason, I usually only invest in businesses with an economic moat.

In order to understand Hotel Chocolat's business model, it's important to understand that operations are not limited to chocolate manufacturing but also encompass cocoa growing.

In my opinion, this vertical integration (which covers the entire supply chain from cocoa bean to finished chocolate bar), serves as a potential genesis for a narrow but growing economic moat. Vertical integration provides Hotel Chocolat with greater control over the quality of product, availability of ethically sourced raw materials, and the overall production process, making it challenging for competitors to replicate their offerings and match the quality of product.

In addition, what makes Hotel Chocolat a potentially compelling investment in my eyes is that on top of owning and operating their own cocoa farm in Saint Lucia, they also maintain strong relationships with cocoa growers, encouraging ‘gentle farming’ practices which are ‘kind to nature and communities’. In return, Hotel Chocolat pay farmers a double-digit premium for their beans. These practices in turn ensure that Hotel Chocolat’s supply chain is free of deforestation, child labour and forced labour. Practices that are unfortunately all too prevalent in the coca bean industry.

See this report by the Food Empowerment Project for further details:

More cynical readers may question what ethics has to do with economic moats.

Well, I argue that as well has having a positive ethical effect, the above practices are also a source of a potential economic moat as they align with the growing consumer demand for ethically sourced and sustainable products. As consumers become more conscious of the social and environmental impact of their purchasing decisions, they are often willing to pay a premium for products that support these values.

Ethical and sustainable sourcing is front and center in the consumer's mind when it comes to sustainability with a 2022 Deloitte survey noting that 56% of UK adults consider that goods being responsibly sourced and harvested make a product sustainable with 28% noting that this is a consideration when considering a purchase.

In a nut shell... I argue that competitors already at scale will find it incredibly difficult to match these ethical standards increasingly demanded by consumers in their already established supply chains often focused on cost.

Nevertheless, given the crowded premium-chocolate market and the presence of big-name players such as Lindt and other supermarket-placed brands, I would not be comfortable in assigning Hotel Chocolat an economic moat at this point.

I also do not underestimate the ability of the industry's big players to clean up their supply chains or to meaningfully compete for ethically minded consumers through lower volume subsidiaries or by way of acquisition.

However the seeds are there for a meaningful economic moat to be formed, only time will tell if these seeds blossom to present a meaningful competitive advantage.

Conclusion: No current moat, but possibly trending towards a Narrow Moat over the long term.

Past Performance

Hotel Chocolat has undoubtedly had a rough ride since the coronavirus pandemic for a variety of factors with the company recording net losses in 2020 & 2022.

See below revenue and net income after tax to 2022 and FY 2023 estimates based on the interim results. I have then provided my forecasts through to 2027 in grey.

Clearly these are disappointing results however I would argue that these results are not wholly reflective of the business' underlying fundamentals if we strip out the disaster that is international sales.

Although I can write off Covid and the joint ventures as simply one-off items, It wouldn't be fair to note that all the group's recent poor performance is down to one-off occurrences.

One thing that does worry me is the company's falling gross margin.

A declining gross margin is a red flag to any business-perspective investor as this is usually a sign of a lack of economic moat, a company's inability to pass on increased costs to consumers, a company's need to compete on price (a company I would never invest in after I learned the hard way following my investment in Card Factory)

Anyone working within the production/manufacturing space will know that wages have climbed substantially over the past 5 years and continue to climb. Indeed, this very fact is one of the core reasons UK inflation remains persistent where the USA have managed to get theirs under control. 

A few days ago, the ONS released their most recent data on weekly earnings by industry and this trend sees no sign of abating. In the past 5 years, C1 wages (the category for Food, Beverage & tobacco manufacturing) increased from £517 p/w in April of 2018 to £636 p/w in April of 2023. A breathtaking increase of 23%.

Although I think that the bulk of the wage rises are now done with, I think we will continue to see moderate increases in manufacturing wages at this new normal. I have therefore assumed a continuation of the current 58% gross margin base in my modelled forecast.

Hotel Chocolat's biggest problems

Hotel Chocolat is widely recognized for its expertise in producing high-quality chocolates. It has established a strong reputation in the chocolate industry, which has contributed significantly to its success. However, recent developments indicating the company's expansion into non-chocolate products raise concerns about its strategic direction.

One possible justification provided by management for this diversification is the company's vision to become more of a 'cocoa' company rather than solely focusing on chocolate. While this argument may have some validity, it is essential to recognize that chocolate remains the primary revenue driver for Hotel Chocolat. Therefore, it would be prudent for the company to prioritize and emphasize its core chocolate offerings.

The introduction of alcoholic drinks and skincare products by Hotel Chocolat raises questions about the underlying motives behind this diversification. One worrisome explanation could be that the company has already saturated its core chocolate market and is seeking new avenues for growth. If this is indeed the case, it suggests that the company is struggling to sustain its growth trajectory solely through its chocolate products.

Moreover, the fact that Hotel Chocolat's co-founders, Angus Thirwell and Peter Harris, own a majority stake in the company raises another possibility. It is plausible to speculate that these non-chocolate products are a result of an overly ambitious leadership approach, characterized by a "perma-bull MD/CEO" mentality. This refers to a mindset where there is an excessive desire to conquer every market simultaneously, potentially overlooking the risks and challenges associated with such a strategy.

Should the hunch regarding an already saturated chocolate market prove to be accurate, Hotel Chocolat could face significant obstacles ahead. Competing in an overcrowded market would likely result in intensified competition, lower profit margins, and potential dilution of the brand's core identity. Therefore, it is crucial for the company to carefully evaluate the market dynamics and consumer demand before venturing into new product categories, ensuring they align with its core strengths and customer expectations.

Indeed, while diversification can be seen as a strategy to expand revenue streams, I would argue that it detracts from the company's core focus and dilutes its offering. Peter Lynch famously called this 'diworsification'. I'm reminded of Microsoft's lurch into the mobile phone hardware market here with their $7.6bn acquisition of Nokia.

When considering a company’s product offering, I like to take a snapshot of what I think their Marketing Bullseye looks like in order to sniff out potential lurches for revenue over quality earnings.

The Marketing/Product Bullseye is a way to visually represent different aspects or categories of products or offerings provided by a company. Each circle on the target board represents a specific category or group of products, with the most important or core products placed at the center of the bullseye.

The idea is that the closer a product is to the bullseye's center, the more central or vital it is to the company's core focus or brand identity. As you move outwards from the center, the products become less central but still relevant to the overall offering.

Here's where I landed when analysing Hotel Chocolat:

As I hope is evident here, the company's focus on anything outside of the primary and secondary circles is to me a miss-step - especially when you're trying to focus on growing these revenue streams alongside trying to crack the worlds largest and 3rd largest consumer markets at once (The USA & Japan).

Looking to the future

According to a 2020 survey by Mintel, 58% of UK chocolate buyers say ethical sourcing is important to them when purchasing chocolate products. Another study by GlobeScan found that in 2020, 51% of UK consumers actively sought out ethical and sustainable products, a significant increase from previous years.

The increasing demand for ethical and sustainable products, including chocolate, among UK consumers presents a significant opportunity for the company. With a growing emphasis on ethical sourcing and sustainability, Hotel Chocolat's commitment to these values can give them a distinct advantage in the market.

As more consumers prioritize ethical cocoa sourcing and actively seek out sustainable products, Hotel Chocolat's focus on supporting ethical supply chains positions them well to meet this demand. By aligning themselves with a brand that emphasizes ethical and sustainable practices, consumers can enjoy premium chocolates while contributing to a more ethical and sustainable chocolate industry.

In terms of investment proposition, the short-term challenges faced by Hotel Chocolat, such as the impact of Covid and failed overseas ventures, have potentially caused the market to undervalue the company's shares. However, it is worth noting that Covid is now over, and the management has learned from their overseas ventures and adopted a more cautious approach to future expansion.

With the joint ventures in Japan and the USA written off, Hotel Chocolat can focus on its UK growth journey, which historically accounted for the majority of its sales (with only 3-5% coming from the failed Japan USA ventures).

The shift towards a capex-light and low-risk licensing approach for overseas expansion further strengthens their position. While it's important to acknowledge that the growth story may take longer to unfold than initially anticipated, patient investors may still be rewarded in the long term

Fair Value Estimate (Discounted EPS)

I took the 2023 store numbers of 123 and projected incremental growth to 173 by 2027, following management plans.

I assumed a conservative 10% growth rate for like-for-like sales over this period, considering the actual growth since 2020 is 25%, which is substantial even with post-COVID recovery taken into account.

I then calculated in-store income by multiplying the number of stores by the income by store.

Similarly, I estimated a 10% growth in non in-store sales between 2023-2027, which I believe is achievable based on more bullish estimates from analysts.

It's important to note that I assumed no international sales. If the international expansion miraculously succeeds this time around, it would significantly impact my model positively.

Assuming a 58% gross margin, I then adjusted selling, general, and administrative expenses to achieve a 19.8% EBITDA by 2027. This falls slightly below management's expectation of reaching 20% EBITDA over a shorter time period.

I assumed flat depreciation and amortization, considering the company's assurances that their new production facility will support production up to 450,000 pieces of chocolate, as shown in the final slide of their 2023 interim result. (Current output is 300,000 pieces, indicating that the 50% production headroom is more than sufficient to accommodate my estimates of 10% revenue growth

Therefore, I don't anticipate any significant capital expenditures that would drive depreciation above current levels.

Based on these assumptions, and assuming a 15% tax rate (roughly accounting for R&D relief capital allowances and relief on losses), I have arrived at my net income results for my model.

It's worth noting that utilizing my method, my 2023 net income assumption results in £6.1m, which falls within the range of management expectations of £4-7m.

To reach my EPS assumptions, I assumed a share-count increase of 1% compounded across each year, resulting in a 4.1% growth in basic shares. I am optimistic that this growth rate will be lower, considering that major capital expenditures related to the new warehouse are complete.

I then utilized a discounted EPS model to determine the fair value of the shares, assuming a 10% risk-free rate and a 2% terminal growth rate after 2027. However, I am optimistic that the growth rate will be higher than 2% beyond 2027.

Based on my calculations, the fair value of the shares is determined to be £1.79 per share. This value is 22% higher than today's share price of £1.40 per share.

Therefore, this indicates that the shares may be undervalued.

Frugal Student Verdict: BUY as a higher-risk potential turn-around play.

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Coronavirus opportunities: AutoTrader Group PLC

Finally, fear has returned to the markets and I can once again think about going shopping.  Whilst it’s true to say that markets are still lofty, we can never predict…

Finally, fear has returned to the markets and I can once again think about going shopping. 

Whilst it’s true to say that markets are still lofty, we can never predict its future movement – as such softly accumulating at these levels is not a bad idea. 

As buffett

Over the past week I have used 1/4 of my dry powder to add to current positions to my portfolio, I also have a fair few companies on my watchlist.  

A company I have had my eye on for a while is AutoTrader Group PLC, a classically boring company that holds a near monopoly over car sales listings in the UK.  

Trading at a P/E of 21 at the time of writing even after a 25% haircut from the market, it may appear over-valued at first glance but given it has returned to levels last seen in November 2019, it’s worth a closer look. 


AutoTrader Group Plc is an online only company that offers a digital marketplace for individuals and businesses to buy and sell new or used cars online.  

Traditionally a printed publication shipped out to all parts of the UK, the management has been able to effectively transition the business to an online-only model which has effectively removed costs from the business.

AutoTrader Group Plc generates revenue through charging private sellers and car retailers to list cars on their website. 

Economic Moat 

As a business perspective investor, the first thing I like to do when considering a potential investment is to take a step back and to consider the underlying dynamics of a company.

I usually try to answer the following questions which usually hint towards the existence or lack of economic moat.

Does this company have to compete fiercely with competitors?

If this company raised prices by say 5%, would people switch to a competitor or stay put?

Can this company pass on any supply side cost increases to customers?

After asking these questions and investigating the likely responses, I concluded that AutoTrader Group Plc possesses a wide economic moat.

But where does this moat come from?

The moat is derived from two sources.

Firstly a network effect stemming from their dominance of online car advertising in the UK with 85% of all adverts being posted on their platform.

Secondly, the moat is entrenched further by AutoTrader’s heavy investment in data services which means it provides buyers and sellers with unmatched information on selling prices and vehicle history.  Such a large database of information and sales history forms an intangible asset difficult for competitors to replicate. This data-trove was further bolstered by AutoTrader’s 2019 acquisition of vehicle data company Keeresources Ltd. The utilization of this data creates an unrivaled user experience both informing and empowering consumers.

For example, the listing below lets the buyer know that the listed car is priced fairly but is £513 above the market average. I believe only AuoTrader would have a database of selling prices large enough to present such information accurately, further widening it’s moat. 


The effects of the moat are clear: Sellers want to sell on AutoTrader because it attracts the most eyeballs and buyers want to search for cars on because it attracts the most listings. The price paid for advertisements doesn’t really come in to the equation. 

Whilst it is my view that the best moats can be identified easily by glancing over a business and thinking about it rationally, many readers like this perspective backed up by the numbers, so let’s look. 

My favorite measures for the existence of an economic moat are gross and operating margin.

Although not always true, the existence of high gross margin figures and high operating margin figures usually indicates the existence of an economic moat (I tend to look for >80% and >20% respectively). 

This is because it indicates that a company may not have to cut its margins in order to compete.  

I wasn’t able to find costs of sales figures for AutoTrader, but operating margin figures against revenue displayed below shows that AutoTrader shows all the signs of a ‘moaty’ business. As revenue has increased so has operating margin indicating increased efficiency and the success in growing revenue without cutting prices. 

These are the best types of businesses – ones where new revenue flowing through the business increasingly trickles through to the bottom line.



We can also turn to the company’s Capital Expenditure figures just to ensure that there isn’t any income statement manipulation going on.

Sometimes, it’s possible for companies to display very high operating margins by capitalising normal business expenses thus removing them from the income statement. 

With Capex consistently under 2% of operating profit, we can confirm that this is not a risk. 


Utilization of free cash flow

One sign that AutoTrader Group PLC may not merit its 22P/E ratio is that it appears management may be running out of ideas to put capital to good use. 

A key indicator of this is the increased allocation of capital to share repurchases and dividend payments. 

 As evidenced in the graph below, in 2018 a concerning 78% of the £189m generated in free cash-flow was eaten up by share repurchases and dividend payments. 

Whilst buying back shares and paying dividends rewards investors, one would expect more allocation of resources to growth opportunities given how the market is currently pricing AutoTrader Group PLC’s stock.

Let me emphasize, I am a lover of share repurchases as they increase an investor’s ownership stake in a company.

In fact, I have applauded Next PLCs buybacks on several occasions.

BUT a company buying back shares at a P/E <15 is different to a company buying back shares at a P/E of >20.

To me, share repurchases should be reserved for mature companies trading at reasonable valuations not for companies that grew EPS by 10% in the previous year.

Considering these figures with the very small capital expenditure spend, it may be the case that growth is running out and thus 22 p/e is a price not worth paying. 

Looking into my crystal ball – a fair value estimate

Ultimately, a company is worth all of it’s future cash flows discounted back to today’s value considering the time value of money. 

Considering the future growth paths for AutoTrader Group PLC, I will conservatively estimate earnings growth of 12% over the next 3 years dropping to 10% over years 4-6 then reducing to a normal growth rate of 3.5% into perpetuity. 

The basis of these estimates are previous organic growth, analyst estimates and an assumption of a 2% per year reduction in the share count (2.6% between ’16-’17, 2.8% between ’17-’18, 2% between ’18-’19).

I will use a discount rate of 9% reflecting the relative safety of earnings and the record low risk free rate in the UK.

As I am happy that there is no earnings manipulation happening, I used EPS as the basis of my calculation.

The calculation resulted in a Fair Value Estimate for Autotrader Group PLC of £3.98 per share.

As such precise calculations are intrinsically flawed as they rely on human judgement, I like to assign a fair-value range to stocks in order to include a margin of error of the exact calculation.

Giving a 5% margin for error on either end, a fair value range for AutoTrader Group PLC would be between £3.78 and £4.18 a share.

Red line = Fair Value

In closing

Quality businesses such as AutoTrader are usually tough to buy at around fair value. As such, even though AutoTrader Group PLC’s shares appear to be around 12% over-valued, this is based on conservative estimates and it may be worth opening a very small position at these levels.


I have passed up several opportunities in the past for being ‘over-valued’ based on discounted cash-flow and dividend models and most have gone on to materially outperform. Experience tells me that high-quality cash generative businesses tend to remain ‘over-valued’ on traditional measures.

I sometimes refer to this as a ‘wide moat premium’

FrugalStudent Verdict: HOLD (Add lightly at £4.18, add heavily under £3.78)

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Card Factory – Confirmation bias and realizing my mistake

Post-purchase rationalization: The tendency to retroactively ascribe positive attributes to an option one has selected and/or to demote the forgone options. It’s been quiet around here, but I have finally been…

Post-purchase rationalization: The tendency to retroactively ascribe positive attributes to an option one has selected and/or to demote the forgone options.

It’s been quiet around here, but I have finally been inspired to write an article.

You could be forgiven to think that I would write about the exemplary performance of Greggs Plc which have gained 130% since I first tipped them in 2016 .

Alas, it would appear that I am much more of a critical thinker.

Instead I will focus on ironing out my mistakes, not patting myself on the back.

Today I will focus on my investment in Card Factory Plc and will dissect why a critical dose of post-purchase rationalization bias blinded me from the clear deterioration in business fundamentals.

The decision to purchase Card Factory Shares

I was first convinced to buy Card Factory shares in September of 2017 after what I thought was market over reaction causing the share price to drop 15%. I saw that the business had very strong cash generation, great margins and seemed to have a clear edge on rival Clinton cards and supermarket stockists.

During this period, I saw predicted that Card Factory’s margins would be stable and that management would expand further into the online market, but the investment clearly hasn’t worked out with a 60% decline on my purchase price.

To be fair, I predicted much of the problems Card Factory would face back then, in my original article on Card Factory shares I noted the difficulty that the retailer would have in maintaining margins due to it’s price-orientated model but I was convinced that the company would succeed in cross-selling higher margin products and that a lid could be kept admin expenses (mostly business rates and the wage bill) as a proportion of revenue as the increase in online sales would dwarf the increases in admin expenses from physical store openings.

I noted;

“I see clear opportunities ahead with a very impressive 30% growth in online Sales (although from a low base) and the expanding revenue an encouraging sign of demand for Card Factory’s products. Although the price of cards have clear price ceilings, there is always the probability of an increased focus on cross-selling products such as balloons, mugs e.t.c where Card Factory can afford to pass the costs on to the consumer.”

So where did it go wrong?

  1. Card Factory’s management continued to expand the number of high street stores to grow revenue despite declining footfall. This means Card Factory is consistently ‘working harder’ to convert revenue into free cash when compared to online sales.
  2. I failed to notice the poor margins on cross-sold products.
  3. Card Factory’s management continued to pay out special dividends instead of putting the money to creative use.

Now, let’s work through this list together.

Card Factory’s management continued to expand the number of high street stores to grow revenue despite declining footfall

“Revenue is vanity, profit is sanity”

Unfortunately, the quality of Card Factory PLC’s management team pales in comparison to the great names running other constituents of my stock portfolio, the likes of Lord Wolfson of Next PLC for example.

Instead of taking prudent measures to protect margins and the bottom line management has embarked on a 50-store-a-year expansion program that has weighed heavily on net cash generation and net margins despite management’s claims to the contrary.

Astonishingly, management appear somewhat unaware of the margin decline or, as I would suspect more likely, are polishing a turd in the hope that the casual investor won’t dig too much in to the numbers.

Here’s what they had to say regarding margins in the 2019 half year report;

Our margins remain strong and, whilst we have seen some impact from National Living Wage and the additional cost of holding increased stock levels (for Brexit contingency planning, investment in new lines and the acceleration of seasonal buying), we remain on track to deliver another year of business efficiencies.”

Strong margins, really?

I crunched the numbers and the decline in both gross and net margins should certainly worry investors despite management’s assurances to the contrary and I would certainly hope that alarm bells are ringing internally.

Such a blase attitude from management in the half year report worries me an investor.

See below the clear deterioration in both gross and net margins (line graphs) against revenue growth (bars).



We can see where they hype from the initial IPO came from with very strong net margin performance in 2016 followed by dismal year after dismal year. It may be worth noting that Karen Hubbard became CEO in 2016 and has evidently failed to steer the ship prudently.

Management has attributed the decline in net margin to increasing store costs, falling high-street footfall and increases in the national living wage, three valid factors in my opinion. I would add to these factors worsening product mix with revenue growth being driven by new store openings and volume. In other words, Card Factory are opening more stores but are selling less high-margin items.

It is startling therefore that management’s answer to these problems is to continue to open more stores on the declining high-street thus increasing the administrative expenses of the business and expanding on the very problem they note as being responsible for poor performance.

The below graph juxtaposing the number of stores and the revenue per store does more than words could to illustrate this dead-end strategy.



Obsession with Special Dividend

When businesses run out of ideas on what to do with spare cash they pay special dividends.

There’s no denying the significant sums of free cash that Card Factory continues to throw out despite margin declines.

As illustrated below, despite management’s best efforts to labor the business with increased admin expenses my FrugalStudent FreeCashFlow measure (A fancy name for how most calculate FCF which is Cash from operating activities – Capex) still shows healthy free cash generation of £56m in 2019 and healthy generation into 2020 and 2021 on a simple linear forecast basis.


With all this free cash one would imagine that management would find some use for it.

Now, I’m the first to criticize large vanity acquisitions and the effective burning of shareholder’s cash but one would feel that the pausing of high-street store openings and a heavy focus on online sales would have been a prudent avenue to put this cash to use.

Doing so would have lightened the load added on to the company’s admin expenses and presented a healthier net margin position.

The below graph displays the cash flow position after dividends in each year

I wonder where Card Factory got the money to open stores and pay dividends larger than their free cash flow?

Ah yes, good ol’ debt!

Let’s take another look at that graph but with long term debt added in.

Eagle-eyed readers would not in return that total assets have increased at a similar pace and that leveraging the balance sheet in such a way isn’t uncommon.

True. But with declining margins and a sagging bottom line, cash will increasingly be chewed up to service debt that will eventually need to be repaid from the declining free cash generate by the business.

Nevertheless at just 5 x 2019’s FS* FCF total debt isn’t too much of an issue as long as investors see a return from the 130m lumped on to long term borrowing in 2019 and dismiss the prospect of reviving special dividends in the near to middle future.

In short, management have mortgaged today’s business to pay out special dividends that the future business will have to repay.

I certainly predict on this basis that CEO Karen Hubbard will leave the business, passing her failed legacy on to someone else to deal with à la Andy McCue of The Restaurant Group.

A glimmer of hope

In November, Card Factory started supplying some Aldi stores with cards under the ‘everyday value’ brand with the view to supplying  440 current stores in the near future. Price sensitivity will be of key importance though with the other half of Aldi’s store estate being supplied by Card Factory’s rival IG Design group.

If my suspicions are correct, Aldi will pit both companies against each other in an aggressive race to the bottom once volume has been established through the stores. I do expect however that Card Factory’s vertically integrated model would give it an edge in such a scenario and hopefully will succeed in pushing out IG Design. The best businesses, however, don’t need to compete.

Card Factory also announced the imminent roll out of its card offering to The Reject Shop’s 360 stores in Australia, the logistics of which appear somewhat perplexing. We will have to wait and see what results, if any, this partnership yields.

These are exciting developments and should have been sought as an alternative to the overzealous store expansions which will only increasingly labor the company’s bottom line.


What was once hailed as a cash-generative high margin business is generating less cash and has lower margins.

The main lesson to learn from the purchase of Card Factory shares is that one should only ever buy businesses an idiot could run. A investment worthy business is one with such an ingrained competitive advantage that it can resist poor business decisions and leadership. Card Factory evidently isn’t one of those businesses and should not have been purchased.

The 60% decline in share price since my purchase is completely justified and it is clear that Card Factory possesses no economic moat despite historically strong cash generation.

Moving forward, I will continue to hopelessly hold the shares over the medium term in hope that management shift focus to their online offering, pause the store roll out and seek other retail partnerships, hopefully stores with more premium offerings where margins would be more robust. This could be done with an increased focus on premium card ranges.

In my opinion, as a humble investor, Card Factory could take the following five steps to turn performance around for the benefit of shareholders.

  • Pause the store roll out and invest in efficiencies in existing stores that will put a lid on rising administrative expenses.
  • Focus heavily on driving volume online where costs are lower.
  • Roll into to cut costs and maintain focus.
  • Karen Hubbard should step down as CEO
  • Card Factory should continue to seek retail partnerships and should en-devour to launch a more premium card range with a premium retailer.

As always, I’m interested to know if you hold Card Factory shares or are considering selling.

Are Card Factory shares a buy or a sell here for you?


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Superdry PLC – Time to buy or is this a value trap?

Superdry – a once thriving brand brought down to earth by the reality of fads and market trends. It would appear the whole high-street clothing industry is falling to tatters…

Superdry – a once thriving brand brought down to earth by the reality of fads and market trends.

It would appear the whole high-street clothing industry is falling to tatters bar a few strong performers lead by exemplary leadership, mainly Next PLC.

This has led to many investors speculating as to the true value of the listed high-street retailers with many screaming “buy” at these “bargain prices” or “sell” because “high-street retail is dead”.

With the current troubles at Superdry, I thought it would be a good time to dive in for a deeper look.

Are Superdry shares a buy here?

A few years ago, I would have already bought Superdry shares at this point and would be hashing out a justification ready for this blog.

My once fixated value approach to investing would be pointing out the apparent value of the shares here.

After all, the prospect of a miracle turnaround by Co-founder Julian Dunkerton (pictured left) is an attractive one. Superdry isn’t a brand that’s going to disappear anytime soon, even if it is as old and tired as I suspect.

I speculate that the main problem facing the brand is the damaging manner in which its largest intangible, the brand name, was treated by the outgoing management team.

Constant discounting has doubtless reduced the brands value in the eyes of consumers.

Alarmingly, instead of following the successful margin-led strategy of Lord Wolfson at Next – Superdry management had opted for revenue vanity exemplified by a stack ‘em high and discount them ‘till no tomorrow strategy so disastrously followed by failing retailers such as Debenhams.

Before we even think about valuation, we must put our business hats on and take a look at Superdry as a company.

In order to assess a company, I like to ask one questions as part of my initial screening.

Does the company have an economic moat and if so is it narrow or wide?

As you will read in the remainder of this article, I believe the damage to the most valuable of intangibles, the brand, means that any idea of a moat that Superdry might have once enjoyed has all but disappeared. As such, the balance of risk and reward in the investment remains stacked against the investor despite the appearing bargain basement valuation of Superdry at present.

If you remain unconvinced by my new ‘moat’ approach to investing, here are the two main reasons as to why moats are important.

a) Moaty businesses have the ability to generate excess returns well into the future by defying one of the fundamentals of capitalism “excess returns are competed away to the cost of capital”.

b) Moaty businesses are more forgiving when management make terrible decisions. This is down to superior economics. Just look at Microsoft’s venture into mobile.

Microsoft had such an outstanding economic moat, it survived having this guy run it…

Think about it this way, if you put the best jockey in the world in charge of a donkey, it still wouldn’t win the grand national. Put me on a champion horse in a race against donkeys and I’m pretty confident I would win the grand national!

It’s the underlying business that matters – nothing else (until we come to valuation that is).

The key is to look at the business before the valuation.

In my experience, value stocks are usually cheap for a reason and nowadays I’m not really interested in turnarounds unless the company has a moat that is intact or can be repaired.

Of course, a moaty business at the wrong price is still a poor investment and the best businesses are moaty businesses selling at deep value, but they are often very hard to find.

This isn’t a rant against value investing by the way, I have just found from experience that it is incredibly hard to determine accurate fair value for stocks and that value stocks are often cheap for a reason.

So, let’s take a look at Superdry, a beaten down beauty or cheap for a reason?

When looking for the existence of an economic moat I like to look at the following metrics.

Return on Equity (ROE), Return on Capital Employed (ROCE), Gross Margins and Operating Margins.

On top of this I take a look at the company’s industry and the economics of that industry as well as the company’s market position and intangibles (brands, patents and talent).

I then try (knowing that I will fail) to foresee what the future of the company may be and to haphazardly estimate the potential cashflow of the company 5 to 10 years from now.

What I would say at this point though, is that it is often obvious when a moaty company is undervalued. Some of you may think that this is a somewhat lazy, blasé statement but from my experience there is a conviction ‘feeling’ that one gets when an incredible company is going for cheap.

Like Facebook at $140 and Altria at $45, it just knew that the market was being far too pessimistic for reality and size of the companies’ economic moat.

Saying this, there is still plenty of time for me to be proved wrong here!

So, let’s take a look at the metrics


Looking at the company’s ROE we can see some evidence of a potential economic moat.

With ROE ranging from 11.34 – 18.65% are getting a return on their capital which is above that of the cost of capital and above that of most retail peers but notably below ‘exclusive’ luxury brands such as Burberry (more on that later on!)

The apparent weakness in 2014 and 2018 does worry me a little despite 2015 and 2017 providing exceptional returns. I like to see ROE which is consistently in the high teens and although the degree of variation here is a little worrying it’s not enough for me to cast aside the idea of investing in Superdry. With ROCE also being modestly high we can be confident that Superdry has historically put capital to good use.

To summarise ROE and ROCE – These are not the best numbers I have ever seen but they’re pretty decent.

While a gross margin of 58% is encouraging, it had been as high as 61.6% in 2016, I’m also troubled by the steady decline in Superdry’s operating margin. Down from 14.3% in 2014 to 11.5% in 2018.

Declining margins are a sign of an eroding moat or no moat at all!

How come?

Well, these declines indicate higher operational or product costs that can’t be controlled or passed on to the consumer. Either that or the need for the Superdry to cut prices to compete. Moaty businesses on the other hand can easily pass on increased costs.

Other clues

Looking for clues as to the brand’s underlying strength we find a troubling trend.

It would appear that management has tilted to a ‘revenue growth at all costs strategy’ which may have deteriorated the brand.

One such sign that worries me with retail companies with deteriorating margins and constant sales to be seen in-store is when account receivables balloon.

We can see that in 2014 that receivables accounted for just 9.26% of Superdry’s non-current assets. In 2018, receivables make up 16.21% of total assets. To me, this suggests that the company is extending more favourable payment terms (possibly in its wholesale arm) as a way of increasing revenue.

The industry and Superdry’s competitive positioning

To me, Superdry is somewhat of a unique company.

On one hand it is a brand and on the other hand it’s a ‘mass-market’ retailer.

It’s a company that’s squeezed between the mass-market retailers themselves such as Next, Zara, Topshop e.t.c and the more exclusive designer labels such as Burberry.

This squeeze is evident when we compare Superdry’s core ratios that I detailed above against that of a true designer brand – Burberry for example.

Whereas it was a once fashionable brand that could maintain prices and hold very little sale events, it has morphed into Sports Direct, desperately trying to flunk its stock.

It now has an image crisis and it’s hard to see if it will ever recover.

This is the core question for me;

“Is this really a case of bad management or has the brand simply had its day?”

Tying this article back to the criterion I set out, a company with a true economic moat should be able to hold up despite poor management, Superdry clearly hasn’t.

To summarise

Whilst ROE and ROCE remain relatively healthy, declining margins and increased receivables are a cause for concern.

Looking at the industry we can see that Superdry has an image problem and we’ll have to wait and see if the brand can still shift stock at full price now that Euan Sutherland’s discounting days are over.

For me, there is little reason to look further than the business.

With the brand in crisis and margins declining, Superdry has no moat and as such is not a company that I would consider investing in.

If you’re good at valuing shares and judging turnarounds on the other hand, let me know if you think shares are trading at bargain basement prices here!



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CORE GUIDE: Everything you need to know about P/E ratios 2019

The price-to-earnings ratio is the most commonly used, but also the most commonly miss-understood ratio. You look at a stock’s P/E ratio before buying right? The conventional p/e wisdom goes…

The price-to-earnings ratio is the most commonly used, but also the most commonly miss-understood ratio.

You look at a stock’s P/E ratio before buying right?

The conventional p/e wisdom goes something like this.

“Typically anything under 15 is a bargain and anything in the 20s is just way overvalued”

But following such ‘wisdom’ will leave your portfolio lagging.

I have experienced this first hand.

Unfortunately, many new investors and even some experienced ones, are probably looking at P/E ratios the wrong way.

Now, that may come as a shock but by taking a few minutes to read this article you will avoid the most common P/E ratio mistakes and you’ll learn how to properly ‘read’ a P/E ratio.

Priceless information.

This article will focus on four key P/E  ‘themes’ that will help you categorise most stocks just by looking at the P/E.

Here are the themes.

  1. The P/E that tells you nothing (very low or very very high)
  2. Relatively high P/E (20-30)
  3. Very high P/E (50+)
  4. The genuine value P/E

1. The P/E that tells you nothing

I watched a Youtube video a few months back and it made me a tiny bit mad.

It was a video of a guy tipping US Steel stock as a buy.

Nope, nothing wrong with that – but what got me was how he specifically drew attention to the ‘crazy low’ price to earnings ratio.

It annoyed me so bad, I even made a video response (

Not because I don’t like US Steel or even people ‘tipping’ stocks on Youtube.

I responded because it was obvious he didn’t understand P/E ratios and was miss-leading new investors.

Before I learnt about P/E ratios in depth I would have been attracted by this low P/E too!

Hell – I may even have made a video tipping it too!

But, here’s why you should never use P/E alone to value stocks.

It turns out that US Steel is a cyclical stock, even worse, it’s a commodity.

Unless you have some kind of professional insight into the field a commodity is in – and lets face it, most investors don’t have this insight – I’d stay well clear of using P/E as a metric to measure its ‘value’ or investment potential.

So, why is looking at the P/E ratios of cyclical stocks, in my opinion, pointless?

It’ll be easier to explain with an example so let’s take a look at US Steel and take it from there.

US Steel is in the commodity business – Steel.

A symptom of being in the commodity industry means that their business costs depend heavily on the price of ore and their profits depend on the supply and demand for steel.

There is also often excess capacity as there are high barriers to exit from the industry.

Once you build the blast furnaces they’re pretty expensive to close down and then start up again.

Not something I want to be investing in.


Ermmm, here’s why it’s not.

US Steel’s earnings YO-YO so heavily that the P/E ratio becomes meaningless.

Just take a look at the EPS figures below;

There’s no steady trend of decline or progress here.

Who knows what the earnings for 18/19 will be?

The worst thing is – there’s very little US Steel can do to improve the situation.

They have little control over earnings and thus they are evidently extremely hard to predict.

If anyone can take any useful information for informing a buy/sell decision from this, drop me a comment, I’d love to know!

My main lesson has been to avoid such stocks since I have no expertise in them and they are notoriously hard to value.

My advice? Stay away from such cyclicals.

2. The relatively high p/e

Now and again you’ll come across a company that you really like.

For me these stocks are Visa, Mastercard, Facebook and more.

I spotted Visa years ago but didn’t pull the trigger.

Why? Well….. they seemed expensive.

But I soon learnt that there are ‘expensive’ stocks out there deliver tremendous returns, despite constantly appearing ‘expensive’.

I’ll talk about Visa here – since I now own the stock.

I first looked at Visa back in 2015 at around $65.

The P/E back then at TTM? Well 65/2.16 = 31.56

Wow, to me back then, a so called ‘value’ investor, that was just too expensive.

After all – there’s no guarantee of those future returns will materialise.

Yet here we are, in 2019 and the P/E remains around 30 and the share price has more than doubled.

I bet you’re thinking just what is going on here?

The penny came to drop in early 2018, and I finally bought the stock after reading The Little Book That Builds Wealth & Invest in the best.

Believe it or not some stocks deserve higher valuations and their P/E will simply track their rise in earnings.

But we do have to watch out since there are some stocks at 20/30 P/E that are just plain overvalued.

So how to I weed these out?

I stick by these three rules.

Any stock commanding a high valuation must;

a) Have an economic moat
b) Have very strong margins (Usually hand in hand with a)
c) Have a clear and predictable pathway to increasing EPS


Well, to begin with, Visa certainly has an economic moat, being one of only three main players in the payments game and boasting eye-popping operating margins of over 60%!

Earnings history also showed a very smooth upwards march dating back 10 years to 2009 with the only stalling in EPS growth being due to one-off expenses and drops in other operating income, not from core operations that quickly recovered.

The key question that must be asked here is,

Does the quality of these earnings and the security of future growth warrant a 30 P/E?

Only you as an investor can answer that question.

For me?

It’s a yes!

3. The very high p/e

Now we step into scary P/E territory.

I only have one example of a ‘very high p/e’ stock in my portfolio and that’s UK Tonic water maker Fevertree which sports a breathtaking (and not in a good way) P/E of 68.

I think I need to sit down.

I own this!?!

One must be very careful with such companies and my rules for such companies are far stricter.

Here they are;

Any very high P/E company must have;

a) An economic moat
b) Very strong margins
c) Strong history of high double-digit revenue growth.
d)A small market cap
e)High ROCE

As we’ve been over a/b before, let’s focus on points c, d and e.

Why am I focusing on revenue with such high p/e companies?

After all, “Revenue is vanity, profits are sanity”

Well, we would hope with such small companies that money is being ploughed in to expansion and this may hurt the bottom line over the short term.

For example, we may have high selling expenses as products are heavily promoted into new markets.

The only way to try and figure out if the company can maintain this revenue growth is to research into their market (tonics in Fevertree’s case) and to keep a very close eye on progress relative to industry size.

One must also look out for signs of retaliation from existing industry competitors that will drive down margins. (Reading Porter’s Competitive Advantage will help with spotting such moves).

For example, as a Fevertree owner I look very closely at how the company is fairing in the US as this will house most future growth and I also keep an eye on what UK competitor Britvic is doing.

In Fevertree’s case, all currently appears in order with revenue growing nearly 9x in four years.

But – just remember that the bigger a company gets, the harder it’ll get for that revenue figure to grow, hence rule d.

This rule speaks very much for itself.

If you see a company at a £50bn valuation trading at 60 p/e, it’s time to get very skeptical.

That means that the company would have to triple in value to a huge £150bn to mean that you would have paid 20 p/e for your stake in the company at the time it had tripled.

Factor in the time value of money (your money today being worth more than the same sum in 3-5 years) and your purchase must have to perform miracles to have paid off.

But hey, this has sometimes happened!

On the other hand, when we consider that Fevertree has plenty of room left to grow in the US tonic market (if the expansion is successful) then it may not be too ridiculous to envisage the current £3bn valuation growing to £9bn or one of the ‘big dogs’ swooping in to buy this premium brand (Coke, Diageo, Unilever?).

Right, so what about rule e?

What is ROCE and why am I looking for a high ROCE?

The simplest way to explain ROCE is by using a lemonade stand analogy.

Imagine you have a lemonade stand and all is going well.

You decide to invest £100 in order to expand your stand. This £100 could come from equity (share issues and retained earnings) or from taking on debt.

From that £100, you are able to generate £200 in income. 

This means that your ROCE is 200%

200/100 *100 = 200

(Yes I know that this is a VERY simplistic example but it explains the concept well).

For such small companies with the need for us to see our investment grow rapidly in size, then we need to know that the money the company is pumping in to its expansion is really paying off!

Low ROCE would indicate that management is getting desperate and is pumping money into low-quality projects.

This often happens as growth slows and management scrambles for any way to keep investors happy and the share price moving upwards.

As we can see, £1 employed in 2013 would earn the company back £1.05 in 2013

A £1 employed in 207 would earn the company back £1.41

Now – that’s what we like to see.

BUT – we should monitor this trend in case of a sudden drop off due to desperate management and deteriorating conditions for rapid growth.

All that being said, my investment in Fevertree is a huge roll of the dice and I have only invested money that I could face losing 100% of.

Make no mistake, one or two bad earnings reports would see this stock half, or even worse!

4. The genuine value P/E 

Now and again we get to see a stock trading at a low P/E compared to its own 10 year history and the wider market.

Of course, there are often reasons for this and there are seldom bargain basement stocks without an ora of negativity surrounding them.

A consensus wouldn’t make a market now would it.

My favourite examples of the genuine value P/E is Apple, which is currently at a 14 P/E and Next Plc which is currently trading at a 11.7 P/E.

We’ll focus on Next since there’s already plenty of content discussing Apple over at Seeking Alpha.

As recently as 2016 Next was trading at a 15.6 P/E.

As high as 17.3 in 2015.

Today? 11.7.

Now that alone doesn’t make Next a buy.

Maybe there has been some fundamental deterioration in the business.

We must first look into the stock to learn its story.

Doing our research we find out that Next was seen as a FTSE darling, a very cash generative business with a progressing dividend along with generous stock buybacks.

Here’s a company rewarding shareholders.

Taking a glance at Next PLC’s margins gives us an insight into the strength of a company.

I wonder whether this new lower P/E is down to intense competition in the fashion space?

Well, it wouldn’t seem so.

Next has managed, remarkably, to keep tight control on its operating margins.

This may be a sign of some sort of, admittedly narrow, economic moat.

Now adding the headlines of retail gloom together with some investing knowledge it becomes obvious where to look.

While negative industry sentiment is down to some of the drop in valuation, the other reason must surely be the downward trend in revenue (turnover) from 2016 to 2018 and the drop off in operating profit.

Some vertical analysis shows what’s going on here in a much more clear manner than taking the figures at face value.

This analysis shows each line item as a percentage of revenue.

While the first table shows the downward trend of revenue, this second table shows the upward trend in expenses, most notably from 2017 to 2018.

This ‘squeezing’ is evidently putting investors off.

But, for me, this is no problem as every business will experience squeezes every now and again.

Especially in industries such as fashion.

When we balance the cons out with what Next offers, I believe we have a case of ‘genuine value’ here.

Next offers a very safe 3.24% dividend yield and huge cash generation that is being used to buyback shares.

On top of this, despite some big retail companies closing stores, cutting margins and going bankrupt, Next has managed to maintain its operating margins.

Debenhams is down 88% this year, House of Fraser went bust and New Look is closing 85 stores.

Next remains calm and robust, even opening stores.

So, what makes a ‘genuine value’ P/E well, it’s more nuanced than just screaming ‘Value’ at low P/E stocks.

It’s about doing what I did above in order to understand the low P/E and to deem whether it’s reasonable or not.


So there we are.

My P/E rules all laid out.

These rules took me years to develop through hours and hours of reading and many nasty experiences.

If you have enjoyed this article then it would be great if you could share it with friends who may find it useful.

You can also follow me on YouTube here:

Lewys Thomas,
Frugal Student.

2 Comments on CORE GUIDE: Everything you need to know about P/E ratios 2019

Debenhams going bankrupt? ASOS down 40% – Should I invest in retail?

Who do you think would win in a horse race, me or three time champion jockey Frankie Dettori? Yeah, you’re probably right. Frankie Dettori could probably ride blindfolded and still…

Who do you think would win in a horse race, me or three time champion jockey Frankie Dettori?

Yeah, you’re probably right. Frankie Dettori could probably ride blindfolded and still win.

But what if I was riding a thoroughbred and Dettori a three legged mule?

I think I’d win hands down.

How is this all relevant?

Well, there are many three legged mules in retail at the moment and few thoroughbreds.

Let’s start with ASOS’s 40% plunge.

Firstly, let me strip away the headlines and the media spin. Debenhams, Next or Topshop would have killed for ASOS’s top-line growth.

If you’d have asked me a few years ago, I too would have applauded these results.

But revenue is vanity and profit is sanity.

ASOS has experienced somewhat of a collapse in so-called ‘EBIT’ margins from 4% to 2% and a 1.6% drop in gross margin. Factor in the tax paid on these earnings and I ponder how much actual cash is left for shareholders.

It really worries me that not so long ago investors were lining up to pay 60 times earnings for this stock. Alas, it’s easy to sit here now the stock has collapsed and to point fingers at others.

Now, I wouldn’t say ASOS is a mule, just a horse with terrible odds.

Call me crazy but I still think ASOS may have further to fall, especially if they don’t fix the margin problem.

Were I a shareholder, I would like to see management abandon the obsession with revenue growth and move to protect operating margins immediately.

With gross margin healthy, it appears business costs are out of control (processing all those returns maybe?)

An all too familiar sight?

Debenhams on the other hand is almost certainly a three legged mule.

Debenhams now boasts negative net margin of -8% in 2018 and a ballooning gap between current liabilities and current assets.

Most worryingly, the business is toast as it stands.

Locked in to constant discounting to try to liquidate stock to cash, customers circle Debenhams like vultures, waiting, knowing that further discounts will come.

Has anyone bought anything at Debenhams for full price over the past year?

Mike Ashley may well be the only man who can save the business.

Is there a future for High-Street retailers?


Simon Wolfson

Long-term readers will know of my unwavering admiration for Simon Wolfson and his incredible management of Next.

Protecting margins and running the business in a prudent manner.

At the time of writing, Next trades at an earnings yield of 10%.

I have seldom bought a company at such a generous earnings yield and done badly, providing the balance sheet checks out that is.

In short, Next is a good horse with a great jockey. It’s also a horse that I expect to benefit from the decline of wafer-thin margin competitors.

Just take a look at Net Margins;

Looking into my crystal ball, I expect Next to announced it has performed in-line with expectations come the January trading update and investors who sold off the back of ASOS’s share price collapse will feel a bit silly for sharing.

Should this prove untrue, the following decline in the stock price will allow management to buy back shares at bargain basement prices with the hoards of free cash flow the company generates.

Investing in such a financially sound company that’s trading at such low valuations simply because the industry is struggling offers a great risk/reward proposition in my opinion.

Certainly I’m a big fan of Next at any price under 5,400p.

For what it’s worth, I also think that JD Sports Fashion looks interesting at these levels but I have not yet had a deep enough look into the company in order to be confident discussing it on here.

Do you own JD or Next?

Let me know what you think by commenting below.

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Stepping away from Dividend Growth Investing

The blog has been quiet and for that I apologise. But, I have finally finished my PGCE course after the most challenging year of my life. I really should write a blog…

The blog has been quiet and for that I apologise.

But, I have finally finished my PGCE course after the most challenging year of my life.

I really should write a blog about the PGCE course sometime - what an experience. It's crazy how some institutions operate.

Anyhow, the GREAT NEWS is that I’m back, and I’m more motivated than ever!

In September I officially start my journey to becoming an investing professional as I study an Msc in Finance and Business Analytics at the lovely Swansea University.

Now, let's get to the meat of the matter and the point of this post.

Some of you may be concerned at the heading of this post ‘A step away from Dividend Growth Investing’. 

After all, I have stuck patiently by Dividend Investing for 4 years now. Noting it as a low-risk, steady investment strategy – but I’ve been convinced to branch out into some higher growth shares.

Here’s why I've branched out.

Over the weeks following the end of my PGCE course I took myself to reading as much as I could about investing.

I went back over the investors bible, The Intelligent Investor, delved deeply into the methods of the godfather of investing, Warren Buffett, by re-reading Warren Buffett and the Interpretation of Financial Statements and taking a close eye to the outstanding archive that CNBC has created covering Buffett in his own words.

Lastly, I challenged myself to read these two classics; Common Stocks and Uncommon Profits by Phillip.A.Fisher and One up on Wall Street by Peter Lynch. Books I had (stupidly) never read before. It was upon reading Common Stocks and Uncommon profits that I began on my journey of change.

                   This book changed my life.

Am I too young to focus solely on Dividend Investing?

It dawned upon me - as a 24 year old student I was investing into companies that have very high capex and operate in industries that were highly saturated, with little room for growth. It's important to note here that I'm not talking about capex used for investing, but capex that's required just for these companies to stand still.

I was putting money into National Grid a company that had absolutely no prospect of compounding my money at anything more than their admittedly generous annual dividend and snail-like 2% earnings growth - see my earlier post on National Grid shares for my previous rationale. National Grid spends millions on maintaining infrastructure but is regulated as to how much it can charge and thus how much profit it can make. 

I also went head first into AT&T, a company that has leveraged itself massively and has decided to compete with other media giants head first through its acquisitions of Time Warner and Direct-TV. I see very little prospect of above-market returns here, even with a hefty 6% dividend. Again, the capex requirements here are huge and the market already saturated.

Now, there's nothing wrong with T and NG - these are solid picks for older investor approaching retirement. The dividends both look safe and will pay handsomely dividends to those who are willing to forgo share price growth.

Let me emphasise, I am not discouraging investments in such companies, I remain absolutely convinced of reliable dividend payouts from the majority of such low-growth companies, even where high levels of capital expenditures are needed.

But, it’s time to admit that I have been blinded by my obsession of ‘value’ in an investment. For so long I held off buying outstanding, high growth companies, such as Visa, Mastercard, Facebook and Nvidia simply because of their high p/e ratios.

In turn, I missed out on the glaring competitive advantages and ability to make above average returns these companies have.

Maybe it was my fault? Maybe I wasn’t valuing these companies appropriately? But, all looked expensive in relation to their 10 year p/e ratios and the market and all went on to raise emphatically in value, bar Facebook as a consequence of its recent, overdone in my opinion, 20% drop.

Here’s a hard learned lesson – an important one to any investor.

Looking at a company’s 10 year p/e ratio to try and determine value can hoodwink you into missing out on outstanding investments.

Surely I can't be alone in having dismissed outstanding companies with outstanding economic moats simply because they looked expensive relative to their 10 year p/e or because they had ratios upwards of 30 even 40.

Sure, it may assist you in painting a background of the company but it has absolutely no bearing on its current value.

It is very possible that a company’s future prospects have transformed dramatically and as a result the company deserves its high valuation.


Yep, this is in complete contrast to my previous approach to investing where I emphasised that one should only value a company on its current fundamentals, exclaiming that these along with the company’s history are the only facts that one can obtain about a company.

The now glaring problem with this stance is that companies change.

A company with an outstanding economic moat and enviable history of earnings growth may be about to face very predictable headwinds. For example, a pharmaceutical company that has just had a patent expire on its star product.

On the other hand, a company with a dreadful or subdued history may have just launched a star new product that will catapult it to a much higher valuation. Just look at Apple pre and post iPhone.

True. It is incredibly risky to try and predict a company’s future. After all, the future is always uncertain. But, one must remember that one can only ever lose 100% of one’s initial investment and that an investment’s upside is theoretically without limit.

So what’s changed?

I’m still a Dividend Growth Investor.

Dividend growth stocks offer enviable protection in economic downturns and instant returns via dividend for investors.


I am now tilting my portfolio more towards companies with higher growth prospects than my usual ultra conservative investments whilst also retaining many of my previous conservative investments for protection in a downturn.

I have updated my portfolio page to reflect my current portfolio holdings.

Remember to comment below and that I’m always available to answer any questions via

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Why calculating Dividend Cover is flawed…. What I use instead

Some of my worst investments were made back in 2014/15. That’s the year I really got stuck into investing. I blindly piled into stocks I would never buy at such…

Some of my worst investments were made back in 2014/15.

That’s the year I really got stuck into investing.

I blindly piled into stocks I would never buy at such valuations today.

I look at them in my portfolio today and cringe.

Glaxo Smith Kline, Whitbread… It just hurts.

Now, while Whitbread may be a decent buy at these prices, I’m down 15% and to be completely honest, I wouldn’t be buying at these prices regardless.

Luckily, one core calculation and one change to my investment style has stopped me from getting stung further.

In this weeks article, I’m going to share that calculation with you and that change with you.

Earnings Per Share

Now, many of you would have already heard about EPS (Earnings Per Share). That’s simply a company’s net profit divided by the number of shares outstanding.

This is a key measure often touted by company management, brokers, and analysts.

Naturally, when I first got into investing this was also the key metric I focused in on – after all, that’s what the pros and other dividend bloggers were doing.

Little did I know at this point that this focus would lead disastrous investments.

Now, there’s nothing wrong with focusing in on a company’s earnings per share but it’s the use of EPS in order to determine a dividend’s safety that gets me.

Ever heard of dividend cover?

My focus on dividend cover actually lead to me investing into companies with pressed dividends! 

Dividend Cover

Dividend Cover = Dividend Per Share/Earnings Per Share

For example, Company X has earnings of £1.00 per share and pays a £0.50p dividend then the above calculation results in a dividend cover of two.

1/0.5 = 2

Now, on the face of it, this makes the dividend look well covered.

After all, earnings per share could theoretically half and the dividend could still be paid.

One would assume that the dividend safe right?

Wrong, and I’m going to tell you why.

The calculation for Earnings Per Share is: Total earnings/Outstanding Shares.

So far so good.

Let’s assume Company X has earnings of £100 and 100 shares outstanding (let’s keep things simple).

100/100 = £1 Earnings Per Share.

But, what earnings per share doesn’t take into account is Capital Expenditure – the money a business spends in order to maintain, upgrade and purchase new physical assets.

If Company X spends £40 on maintenance and a further £30 on purchasing a new asset the dividend is suddenly left uncovered by cash generated through by the company’s operation.

We said above that the company paid a 50p dividend per share.

0.50 x 100 (the number of shares) = £50 total dividend paid.

Add on the £70 spend in Capital Expenditure and we can see that the company actually forked out £120 while it only generated £100 in earnings.

Where did that extra £20 come from I hear you ask?

Debt, new share issues or asset sales, all of which are reflected in a company’s cash flow statement and can be damaging over the long term.

Debt and share issues are reflected under the financing tab of a company’s cashflow statement with asset sales  under other investing and cashflow items.

So should you worry if a company has to rely on asset sales, debt or share issues to pay a dividend?

Not necessarily but it means you need to dig deeper into a company’s annual report in order to find out exactly what’s going on in order to determine if adding more debt is sustainable and whether asset sales damage the overall business.

As for share issues – this is almost always bad news for investors!


Let’s take a real-world example to see how this all works out

Here’s Whitbread’s Cashflow statement.

We’ll start in 2013.

I always begin by working out a company’s Free cash flow excluding other investing and cashflow items.

This is because I want to see whether a company generates enough cash from its core operations to fund growth and pay the dividend, without the need for any cash generation from Property Plant and Equipment activity such as asset sales.

That’s Total Cash From Operations – Capital Expenditures (Capex).

2013 = £63m

Great, that’s £63m worth of SURPLUS cash that Whitbread has after all costs including Capex.

BUT, we can see that they paid out a £78m dividend meaning that they had to generate £15m.

As it happens, in 2013 WTB gained £50m from an asset sale meaning the dividend is covered (reflected in 2013’s cashflow statement)

Using this formula, we can truly work out whether a dividend is covered.

Do the maths for 2015 and you’ll see that the dividend is grossly un-covered thanks to huge Capex.

Jumping forward to 2017 we can see that the dividend has become even more pressured.

Free cash flow = 626 – 610 = £16m

WOW! The dividend paid in 2017 was a whopping £167m.

Where did the additional £151m come from!?!

Well, if we consider the other investing activities you’ll notice that Whitbread made £200m.

Fair enough right? That covers the dividend.

Well, if we dig into the annual report, we can see that much of this money (186.2m) came from the sale and leaseback of hotels & restaurants.

Thus we have uncovered a red flag!

By leasing back a hotel the company has added an overhead for a one-off payment.

This seems concerning as this sale was required due to the weight of the dividend and the huge levels of CapEx needed in the hotel and restaurant sector.

It’s also worth looking at the company’s liabilities in light of its capital-intensive nature.

                                                                                                          2017          2016         2015         2014         2013

As we can see, total liabilities have rocketed from £1,640m in 2013 to £2,161m in 2017 with total debt nearly doubling.

This isn’t actually that bad considering how cheap debt is at present and considering that the company has also grown its assets substantially.

                                                                                                          2017          2016         2015         2014         2013

We can see that the liability to asset ratio has remained broadly stable (Liabilities/assets)

2013 = 1640/3175 x 100 = 52%

2017 = 2161/4689 x 100 = 46%


Here’s the piece of the balance sheet that makes me cry as an investor.

                                                                                                            2017          2016         2015         2014         2013

Whitbread has issued a further 4m shares since 2013, diluting shareholder equity.

Each time a company issues shares, your stake in the company is decreased.

Someone who owns 1/100 shares in a company owns 1%.

If the company issues another 10 shares, you now own just 0.9%

Whilst 4m shares over 5 years is far from terrible, just 2.2% of total shares outstanding, when we compare this to a company with low Capex and plenty of cash to spare the importance of free cash becomes pronounced.

Here are the number of Next Plc shares outstanding;

                                                                                                           2017          2016         2015         2014         2013

So, how do I REALLY know if a stock’s dividend is under pressure?


These are the EXACT steps you need to do.

  • Get the company’s cash flow statement.
  • Do the following equation: Total cash from operations – Capital expenditure.
  • Minus the dividend from this figure.
  • If the remaining figure is larger than the dividend paid then you can consider the dividend safe.

    Sometimes, stocks pay special dividends if they have surplus cash and don’t want to buyback its own shares or invest it. Because these dividends aren’t regularly paid, it’s unwise to include them whilst considering the sustainability if a stock’s ordinary dividend. As such, remember to check if the stock paid a special dividend. If the stock paid a special dividend following the following steps apply.


  • Get the company’s cash flow statement.
  • Do the following equation: Total cash from operations – Capital expenditure.
  • Minus the dividend from this figure.
  • Plus the amount paid out as a special dividend.
  • If the remaining figure is larger than the dividend paid then you can consider the dividend safe.


Conversely, if there is a need for investing activities in order to cover the dividend payment, you should take a closer look at exactly what’s going on in the company’s Annual Results.

Thanks for reading and I really hope this article has been a help.

If only someone had written this and linked me to it 3-4years ago I’m sure my investments would be in a much better spot.

Once more – I do not make ANY income from this blog. No ads, No affiliate links just me and my laptop.

If you could support my platforms by subscribing to my YouTube channel and sharing this article I would be very grateful.

As always any questions, drop a comment below or E-mail:

1 Comment on Why calculating Dividend Cover is flawed…. What I use instead

Market Meltdown & A Close Look at BT.

Well well, looks like we’re finally getting a minor correction in the market. The FTSE’s down 1.5% and the S&P500 4.4% About time too! With prices continually creeping higher over…

Well well, looks like we’re finally getting a minor correction in the market.

The FTSE’s down 1.5% and the S&P500 4.4%

About time too!

With prices continually creeping higher over the previous two years with little sign of a correction, bargains are getting harder and harder to find.

Saying that, my recent buys have been in for a rough ride regardless, with;

IMB, CARD, and NG faring particularly badly. Between these, I’m down £300 on a £2500 investment, ouch!

I’m not that bothered though, after all, investing is for the long term and I’m confident these companies will bounce right back and are currently trading at cheap valuations, especially CARD.

My goal is always to increase my yearly income through dividend stocks and not to watch the price of my portfolio rise, although that is somewhat comforting too.

This now sits at over £350!

Regardless, one bit of news this week was the lackluster results announced by BT the previous week.

WOW, am I glad I got out when I did!

With BT now at a 52week low, many people have asked whether now is a good time to get into the stock.

If you’re thinking of taking a punt at BT then keep reading.

BT Overview

Over the past decade, BT has transformed more and more into a ‘media’ company as opposed to its traditional fixed-telecoms base.

This has seen the company step into TV, Sport, Mobile whilst investing heavily in a quad-core offering consisting of;


To be fair, BT has been successful in this transformation as the company now looks completely different to how it did just a decade ago. But I remain unconvinced. Here’s why.

Narrow economic moat

Followers of Buffett will be familiar with ‘economic moats’, a term coined by the Oracle of Omaha to describe a company’s continuing and lasting economic advantage.

A wide economic moat denotes a large competitive advantage whilst a narrow economic moat denotes little or no competitive advantage.

Whilst some pundits have argued that BT boasts a medium economic moat with an unrivaled quad-play offering, I think this is unwise.

If we take a look into each of these segments we can see that all are intensely competitive.


Probably the only area where BT continues to enjoy a competitive advantage. BT owns, operates and maintains the telephone lines under its Openreach division and as such BT can continue to enjoy moderate profits in return for its expertise in the area and continued investment through high levels of Capital Expenditure.

But, with the government seems determined to force a spin-off between BT and Openreach buying the stock purely for this competitive advantage would be unwise.


Well, it’s safe to say that EE has no unique offering compared to Three, O2 and Vodafone. Just like airlines, you can offer the best service or best signal in the world but consumers are increasingly focused on price and price alone making charging a premium to increase margins virtually impossible.


Let’s face it. Even traditional TV companies are taking a pounding in the face fierce competition from Netflix and Amazon.

I really think BT made a mistake stepping into this insanely competitive field where they must pay BILLIONS to secure football rights against companies with much deeper pockets (and much smaller pension deficits). Is it really wise to have to add TV rights to a Capex list already containing broadband lines and a black-hole of a pension deficit?

Quick answer: No.


Again, fiercely competitive where BT is straddled with the need for huge Capex to upgrade and maintain the lines but are then expected to compete for customers against the likes of Talk Talk, Origin and more.

Another race to the bottom on price!

Capex, Capex, Debt

Whilst BT rightly boasts it £68m increase in capital expenditure in their Q3 results reflecting their ‘ongoing investment in fiber broadband speed and coverage’ the sad fact of the matter is that BT can’t leverage this large investment in infrastructure to any meaningful competitive advantage due to government regulation.

Most worryingly is that BT is loaded with debt.

£21bn to be exact with we include the dizzying black hole of a pension deficit which stands at £14bn.

Taking a look at BT’s Free Cash Flow forecasts we can see that pressure isn’t going to ease up anytime soon.

(1st grid = Q3 17/18 – 2nd grid = FY 17/18 Estimate)

A full year FCF estimate of £863m leaves BT’s £1.4bn+ dividend payments uncovered.


Many pundits note that BT is looking undervalued at this point with Morningstar releasing this summary of analyst expectations:

But, with no economic moat, it really isn’t a company that I’d be comfortable having in my portfolio having made the mistake of buying it in my newbie investing days.

FrugalStudent Opinion: Hold with the view to sell at a more reasonable p/e.


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